Traditionally, the literature has analyzed the determinants of horizontal activities

of multinational firms—which entail serving the host market—vis-a-vis vertical activities—which entail a form of production fragmentation and trade flows within—and outside—the boundaries of the firm. For the most part, past analysis have been restricted by data availability: When detailed data on affiliates’ activities were available, the coverage in terms of countries was small, and when data for a broad set of countries were available, the detail provided on the affiliates’ activity was very low.

This paper brings new evidence on the determinants of the activity of affiliates of multinational firms in Asia, in the context of global value chains. The analysis relies on a unique firm-level data set provided by Dun & Bradstreet (D& B) with good coverage of the countries in the region. The key feature of the data that makes the analysis possible is the information provided, at the firm level, on the firm’s engagement in international trade activities; in this way, affiliates can be classified as host-market oriented or exporters. The traditional country and industry determinants of different types of Foreign Direct Investment (FDI)—comparative advantage, trade costs, and economies of scale—can be tested in a very precise way for a large set of countries and augmented by production fragmentation considerations (i.e., input-output links) and measures of engagement of countries in the global value chain (e.g., measures of value-added trade and exports’ upstreamness).

This paper evaluates the influence of financial development on the global operations of multinational firms. Using detailed data from the United States, we provide evidence that host-country financial development increases entry by multinational affiliates, while also influencing affiliates’ incentives to sell in the local market, the parent country, and third-country destinations. We rationalize these patterns with a model that emphasizes the interaction of two effects of financial development: (i) a competition effect that reduces affiliate revenues in the host market due to increased entry by domestic firms, and (ii) a financing effect that encourages affiliate entry and activity in the host country.

* Co-Authors: L. Kamran Bilir and Kalina Manova

A key trend in international trade over the last two decades has been the rising fragmentation of production across countries. We use firm-level customs data, matched manufacturing census data, and Input-Output tables from the People’s Republic of China (PRC) to better understand where and how PRC firms operate along the global value chain. We characterize each firm's global production line position by computing the “upstreamness” of each firm's export and import mix, using a measure of upstreamness that reflects the number of production stages between the product mix in question and final uses. We document the evolution of PRC firms' global production line position over the 1992-2011 period. We also show how it correlates with firm performance (total exports, sales) and with various underlying firm characteristics (ownership, productivity, capital and skill intensity).

* Co-Authors: Davin Chor and Kalina Manova

In this paper, we develop a model of fragmentation in the context of product cycles, with Ricardian comparative advantage driving trade of intermediate goods. Basically we incorporate fragmentation and offshoring of final goods into a model of trade in intermediate goods inspired by Eaton and Kortum (2002). Innovation and offshoring are introduced in the product cycle model following Krugman (1979) and Lai (1998). It is a two-country model with North and South. The North carries out innovation as well as production of all intermediate goods and assembles the final good at the earlier stage of the life cycle of the product, while the South carries out production of some intermediate goods and assembles the final good at the later stage. Fragmentation is defined as the separation of the location of production of intermediate goods and that of the assembly of the final good. We find that as the North becomes better in producing intermediate goods relative to the South, it leads not only to a rise in the North-South wage gap, but also an increase in the extent of global fragmentation. An increase in the rate of technological standardization in the production of final goods, on the other hand, lowers the North-South wage gap and raises the extent of global fragmentation. An increase in the North’s capability to develop new final goods, however, lowers the degree of global fragmentation. An exogenous increase in fragmentation, possibly due to changes in technology of production, would increase the North-South wage gap.

* Co-Author: Han (Steffan) Qi

Many studies have found that foreign direct investment (FDI) can play a positive role in spurring economic growth and income of host countries. FDI can take the form of investment in new assets (greenfield investment) or acquisition of existing assets (mergers and acquisitions; M&A). Because of their distinctive characteristics, the two FDI modes may have different effects. This paper empirically evaluates how institutional and policy factors influence greenfield and M&A investment to developing countries. For this purpose, this paper utilizes bilateral greenfield and M&A investments for the period 2003-2014. We offer a number of new findings. Among the three sets of host country-specific factors, we find that the quality of local governance is the most important factor for both greenfield and M&A investments to developing countries, whereas FDI restrictive policies of developing countries are not significant factors in restricting FDI inflows to these countries. We also find that an improvement in host country’s environment for doing business may have a positive effect on greenfield investment only when the host country’s governance quality is very low. Among the pair-specific policy factors, regional trade agreements have a significantly positive impact on greenfield investment flows to developing countries, while bilateral investment treaties do not exert any positive effect either on greenfield investment or M&A investment.

Using data on United States firms' technology licensing to local agents in developing countries, this paper examines the impact of patent protection on internal and arms-length technology transfer. The effects of protection vary across products according to their complexity. Simple products are relatively easy to imitate and so firms producing these products choose the more secure means of transfer via affiliates and subsidiaries, and also rely on a host country's patent rights to further limit the risk of technology misappropriation. Consistent with theories of internalization, stronger patent protection enables local firms to attract more arms-length technology transfer. The attractiveness of affiliated licensing rises as well among simple-product firms, strong enough that the composition of their licensing shifts towards affiliated parties. The results withstand several robustness checks, and are equally strong whether patent protection is measured by its intensity or by the timing of reforms. The results have significance for recent work on the internalization theories of multinational firms as well as for patent policy in the developing world, where access to knowledge is critical.

* Co-Authors: Walter Park, and Kamal Saggi

Since investment-related provisions in bilateral investment treaties (BITs) and free trade agreements (FTAs) are heterogeneous and complex, conducting sound empirical analyses is not easy. In order to overcome this, it is helpful to conduct a “conceptual” work to examine the mechanisms in which investment provisions in BITs/FTAs affect foreign direct investment (FDI), in addition to empirical analyses. All empirical analysis, in order to be compared (over countries, continents or time) should be developed against the canvass of a robust conceptual framework. This conceptual paper provides several hypotheses on the impact of BITs/FTAs on FDI, which can be tested in empirical studies. The following are amongst the important points to discuss in examining the mechanisms in which BITs/FTAs affect FDI: The difference between BIT and investment chapter in FTA in terms of provision coverage; Which provisions in BITs/FTAs are likely to have a significant impact on FDI; The interrelationships among provisions within one BIT/FTA and, altogether, their impact on FDI; The interrelationships among agreements signed by a pair of countries. How does the impact of BITs on FDI vary in combination with FTAs? i.e. when there is a BIT combined to a FTA dealing with trade matters only (e.g. Japan-Malaysia BIT combined to Japan-ASEAN FTA) and/or when there is a BIT coupled to a FTA with investment Chapter (e.g. China-Australia BIT + China-Australia FTA 2015).

The interrelationship among BITs/FTAs signed by one country with various partners, especially through most favored nation (MFN); Under what external conditions (e.g. governance quality of recipient country) are provisions likely to be effective and have an impact on FDI; which provision’s impact on FDI is dependent on external conditions?

We adopt a granular approach to investigate the impact of bilateral investment treaties (BITs) and regional trade investment agreements (RTIAs) on foreign direct investment (FDI). Using detailed and under-exploited databases, our empirical analysis explicitly takes into account the heterogeneity of both treaties and FDI projects. We find that BITs specifically granting access to an investor-state dispute mechanism and RTIAs specifically protecting foreign investors from discrimination have a large, positive, and statistically significant effect on FDI. These results hold when we distinguish FDI flows according to the partners involved, the entry mode, or the destination sector. The focus on specific investment provisions and various robustness checks suggest that our findings are not driven by reverse causality or an omitted variable bias. Overall a `pro-FDI' BIT or RTIA can be expected to increase the number of FDI projects by 35% and 58%, respectively.

Using recent cross-national data, this paper examines the impact of foreign direct investment (FDI) on entrepreneurship. The impact of FDI on entrepreneurship is not clear a priori with the possibilities of both a negative effect (crowding out) and a positive effect (synergy or complementarity). Results find support for the crowding out effect; however, this effect varies across nations with different prevalence of entrepreneurship. Another focus is on gender differences. The crowding out effect is stronger for the full sample, rather than the subsample of female entrepreneurship and this finding stands up to a battery of robustness checks. Policy implications of the findings are discussed.

This paper examines empirically whether Aid for Trade (AfT) programmes and Foreign Direct Investment (FDI) inflows affect export upgrading and, if so, whether their effects are complementary or substitutable. Export upgrading entails export diversification (including overall export diversification, as well as diversification at the intensive and at the extensive margins) and export quality improvement. The empirical analysis shows that total AfT flows have a strong positive impact on export upgrading, and that least developed countries (LDCs) as compared to Non-LDCs, are the most important beneficiaries of this positive impact. While the impact of FDI inflows on export diversification in host economies is mixed, these flows do exert a strong positive impact on export quality upgrading. Furthermore, the impact of FDI on export diversification is higher in LDCs than in Non-LDCs. Incidentally, AfT and FDI inflows appear substitutes (in an economic theory sense) in achieving export diversification and complementary in their effect on the improvement of export quality in recipient countries, including LDCs. Results obtained on the impact of components of total AfT are inconclusive, as they suggest both complementarity and substitutability with respect to FDI inflows in affecting export upgrading in recipient countries.

Overall, empirical results suggest that AfT and FDI inflows are effective in influencing export upgrading in recipient countries. However, the results also highlight the importance of the interplay between these two kinds of capital flows in affecting export development strategies and FDI policies of recipient countries, notably LDCs.

We can infer from this study that AfT flows appear to play a particularly important role in ensuring that FDI inflows do not lead to further export concentration, by putting in place the necessary conditions for export diversification.

* Co-Author:  Sèna Kimm Gnangnon

The Asia Pacific region is a major player in FDI, with developing Asia’s FDI outflows alone accounting for 1.1 times the dollar value of North American outflows and 1.4 times that of Europe in 2014. East Asia alone accounted for 43% of all developing-economy FDI. Increasingly International investment Agreements (IIAs) are being put in place to manage and control these investment flows. According to UNCTAD, by the end of 2014, there were more than 3,200 IIAs in place, where almost half, or 1,500, have been signed by one or more parties from the region.  With the focus shifting towards crafting IIAs to attract the ‘right’ types of foreign direct investment (FDI), there has been more attention on high-technology industries and knowledge economies, and fostering STI competence and capabilities through FDI. In this regard, Science, technology and innovation (STI) related provisions are increasingly included in IIAs and other relevant trade/investment agreements.

This paper examines the current landscape of IIAs in regard to STI in the Asia-Pacific region. As there are no empirical studies identified which deal with STI-related provisions in IIAs of the region, the paper initially examines the degree to which STI-related provisions are included in IIAs and other relevant trade/investment agreements which includes one or more parties from the region. The paper reports the outcomes of an analysis of a sample of signed agreements which include an adequate representation of the population of agreements signed in the region. This analysis consists of a categorization of the types of STI-related provisions based on common themes such as technological and technical cooperation, information technology, clean technology, and Intellectual Property Rights (IPR). It also examines if there are any significant differences by the types of agreements, level of development of signed parties, year of signature, and/or other characteristics. Also, it will attempt to identify if there are any enforcing mechanisms that would prompt countries to implement/revise relevant policies. It strives to examine if these STI provisions in IIAs have any relationship with STI competence and capabilities in host countries.

To analyze the effects of FDI on domestic firms' investment, we use a detailed firm level data-set from the Republic of Korea for 2006–2014. We combine it with the input-output tables provided by the Bank of Korea to construct industry level measures of multinational presence in sectors that are horizontally and vertically linked, and estimate dynamic investment equations that are augmented with these foreign presence measures. We find a positive and significant effect of foreign presence in both horizontally and vertically linked industries on domestic firms' investment rate, with larger effects arising from multinational presence in the supplying sectors. Quantitatively, a 2 percentage point increase in the presence of multinational suppliers increases a domestic firm’s investment rate by 2.29 percentage points. We also find that this effect is larger for small and medium firms, private firms, non-exporters and for firms in external finance dependent industries. A similar 2 percentage point increase in the foreign presence in downstream sectors increases the investment rate of domestic suppliers by 0.71 percentage points. This effect is larger if the domestic firm is part of a chaebol, or is in a less external finance dependent industry. The effect of a 2 percentage point increase in horizontal FDI is also positive, but smaller at 0.42percentage points.

* Co-Author: Kwang Soo Kim

Assessing the productivity gains from multinational production has been a vital topic of economic research and policy debate. Positive aggregate productivity gains are often attributed to within-.rm productivity improvement; however, an alternative, less emphasized explanation is between-.rm selection and market reallocation, whereby competition from multinationals leads to factor reallocation and the survival of only the most productive domestic .rms. We investigate the roles of the two different mechanisms in determining the aggregate productivity gains by exploring their distinct predictions on the distributions of domestic firms: within-firm productivity improvement shifts the productivity and revenue distributions rightward, while between-.rm selection and market reallocation raise the left truncation of the distributions and shift revenue leftward. Using a rich cross-country firm-level panel dataset, we find significant evidence of both mechanisms, but between-firm selection and market reallocation account for the majority of aggregate productivity gains, suggesting that ignoring this channel could lead to substantial bias in understanding the nature of gains from multinational production.

* Co-Author: Laura Alfaro

Using a unique measure of foreign entry regulation, we examine the largely ignored indirect impacts of foreign entry barriers on downstream manufacturing activities in the People’s Republic of China. We find that there exists a significant liberalizing move in the manufacturing sector, whereas restrictions in the service sector remain stringent. Our results show that foreign entry barriers in the upstream manufacturing and service industries curb downstream firm productivity. The effect depends on some industry-specific features such as their distance to the world technological frontier, technology sharing similarity and labor structure similarity between upstream and downstream industries. Some firm-specific features such as R&D investment and service and material outsourcing are vital channels through which upstream regulations impact downstream productivity.

* Co-Authors: Puyang Sun and Wei Jiang

Trade and investment increasingly constitute the main forms of firm internationalization. This paper develops a model for analyzing the effect of financing heterogeneity on firm export and investment. We introduce financing heterogeneity into a classic firm-level model, in which firms face a trade-off in their operational mode depending on external financing capacity: whether to serve foreign markets, and whether to do so through exports or local subsidiary sales. Our empirical analysis yields two major findings. First, only those firms with the strongest external financing capacity engage in foreign activities. Second, of those firms that serve foreign markets, only those with the strongest external financing capacity engage in foreign direct investment (FDI). These results have important policy implications for a country such as the People’s Republic of China (PRC) that is highly dependent on exports for economic growth and yet suffers from weak financial institutions. They suggest that by reducing financing constraints and financial market frictions, efforts to build a more efficient, market-oriented, and flexible financial system could facilitate the internationalization of the most competitive and efficient PRC firms, while at the same time enhancing PRC international competitiveness and promoting the transformation of its mode of trade growth.

* Co-Author: Yue Lü

This paper examines how domestic distortions affect firms’ investment strategies abroad. The study first documents puzzling empirical findings concerning multinational corporations in the People’s Republic of China, which include private multinational corporations, are less productive than state-owned multinational corporations. A theoretical model is built to rationalize these findings and yields additional empirically consistent predictions. The key insight is that discrimination against private firms domestically incentivizes these firms to produce abroad, which results in less tough selection into foreign direct investment for them. A calibration exercise shows the quantitative impacts of domestic distortions on gains in aggregate productivity after investment liberalization.

* Co-Authors: Wei Tian and Miaojie Yu